How is a business loan from director taxed?
Introduction: What are partnership loans and how do they work?
Partnership lending is a form of internal financing in which the partners of a company provide loans to the company. This practice is common in small and medium scale enterprises, where partners can use their own resources to help finance the operations or projects of the enterprise.
These partner-partnership loans can have several advantages. Firstly, they allow the business to raise capital without having to turn to external sources such as banks or other financial institutions. This can be particularly useful when market conditions are unfavourable or when the company has difficulties in accessing credit.
In addition, partnership loans often have more flexible interest rates and more favourable terms compared to traditional loans. This can benefit both the lending partners and the recipient company, as customised arrangements can be made according to the needs and financial capabilities of both parties.
It is important to note that these loans must be properly formalised through legal contracts and properly accounted for in the company’s financial records. This will ensure transparency and avoid possible future conflicts between the partners.
Advantages and disadvantages of partnership loans
Loans from director to his company are a commonly used option in business. These loans can offer significant benefits, but also present disadvantages and financial risks that are important to consider.
One of the main benefits of partner/partnership loans is the flexibility they provide. By making an internal loan, the parties involved have the ability to agree on terms and conditions that best suit their particular needs. This may include favourable interest rates, flexible terms, or even the ability to adjust repayment according to the financial performance of the business.
In addition, internal loans can help to avoid bureaucratic and costly procedures associated with obtaining external financing. Instead of turning to external financial institutions or lenders, businesses can draw on their own resources to raise the necessary capital.
However, it is also important to be aware of the disadvantages and financial risks associated with internal borrowing. A key disadvantage is that these loans can negatively affect relationships between partners if they are not properly managed. Conflicts related to payments, interest or terms could arise and impact on the harmony of the business.
In addition, there is an inherent financial risk in lending money within a business. If the company faces financial difficulties or defaults on its financial obligations, the lending partner could lose its investment.
It is common for individual partners to make loans to the partnerships in which they participate. See below for the main tax issues to consider when entering into these transactions.
The partner loan is considered a related party transaction.
Market interest
Related party cases
If the shareholder making the loan to his company holds at least 25% of the capital or if he is a director, the loan is considered to be a related party transaction . In this case, the interest must be valued at the market interest rate (i.e. the rate that would be agreed between independent parties), applying one of the valuation methods provided for in the Corporate Income Tax (IS) regulations .
For IS and IRPF tax purposes, both the shareholder and the company must declare this market interest rate, even if the interest actually paid is different.
Internal comparables
In these cases, the most appropriate valuation method is usually the so-called comparable free price, with the possibility of using internal comparables (i.e. the interest rate being paid by the company on other loans from banks or unrelated entities). If the company has loans with financial institutions for similar amounts as the linked loan, an ideal market comparable would be the interest rate charged on those bank loans.
If the company does not have loans with banks that could serve as a benchmark, external comparables should be sought, i.e. market interest rates charged on loans received by other companies similar in size, turnover and type of activity.
Other possibilities
If no information is available on any of these comparables, another alternative may be to look for a reference interest rate, such as the statutory interest rate or tax arrears interest. It could be argued that, given the difficulty of obtaining information on other interest rates, these rates are the most appropriate. The regulations themselves use them, for example, to fix compensation between private individuals, or deferrals of payment to the tax authorities.
Documentation
Preservation
In these loans between related parties it is also necessary for the borrowing company to keep the documentation relating to the loan and the justification for the valuation assigned to the interest [LIS, art.18.3]. This is necessary whether or not the company has a formal obligation to document its related party transactions. Bear in mind that, in the event of a tax audit, the company will also have to prove how it has determined the interest rate applied.
Remember that your company is exempt from the formal obligation to document transactions carried out with the same person or related entity that do not exceed 250,000 euros in the financial year – an amount that is unlikely to exceed the interest on a loan. However, you must also be able to provide documentary evidence that the interest declared is market interest.
Taxation of interest on a loan to a company from partner
Special rule
Related lending
Another aspect to bear in mind when a shareholder lends money to a company with which he is linked is that the interest he will receive is taxed in the IRPF in a special way [LIRPF, art. 46.a] :
If the loan does not exceed three times the sum of the equity attributable to the shareholding of the partner, the interest is taxed under the savings income of the IRPF (at a rate of between 19 and 28%).
If the loan exceeds this amount, the interest corresponding to the excess is taxed in the general IRPF taxable base (at a rate that can reach 47% or even higher in some autonomous communities).
Avoiding high loans
Caution
Therefore, in these cases, make sure that the loan granted by the partner does not exceed three times the share of equity that corresponds to it; otherwise, the tax cost of the interest will be higher for personal income tax purposes.
Example 1
A shareholder holding 30% of the capital of a company with equity of 20,000 euros makes a loan of 25,000 euros to the company. Well, if he receives 1,000 euros in interest, the IRPF taxation of this sum will be as follows:
| Concept | Amount |
| 3 x own funds partner | 18.000 (30% x 20.000 x 3) |
| % savings base interest | 72% (18.000 / 25.000) |
| Interest on savings income IRPF | 720 |
| General income interest Personal Income Tax (IRPF) | 280 |
Retention of a partnership loan
Fixed withholding tax rate of 19%.
Enforceability of the withholding tax
When the recipient of the interest is an individual, the paying entity must apply a fixed withholding tax of 19%, which must be paid to the tax authorities via form 123 (monthly or quarterly). This withholding must be made when the interest payment is due, according to the conditions agreed in the loan contract.
Declaration. The partner who receives the interest must also declare it in the IRPF of the year in which it is due . Thus, if it is agreed that the interest is payable annually (the most common case), the income must be imputed to the IRPF of the year in which it is payable, regardless of whether the interest has accrued in full or in part in the previous year.
Alternative: Collection at maturity
Another alternative in these cases is to expressly agree that the interest is to be paid at the end of the contract, i.e. at maturity. In this case, and by application of the due date rule, the partner must declare the income (i.e. the interest) at the end of the contract:
The partner must declare the income (the accrued interest) in the year in which it becomes due (the year in which the loan matures). Therefore, he will be delaying his taxation.
The company, on the other hand, does not have to withhold and pay it to the tax authorities until that time (the due date).
Financial savings
Although in this case the shareholder must pay tax on the interest in accordance with the payability rule, this does not affect the taxation of the company to which the loan has been made, which must continue to charge the interest expense annually, as it accrues and regardless of when it falls due or is collected . This allows for some overall financial savings, since, while the shareholder can delay the time at which he pays tax on the interest, the company can, from the outset, deduct the expense each year.
In any case, delaying interest payments does not always pay off. Remember that, in general, this income is included in the savings tax base and that, as this is progressive, it can vary between a rate of 19 and 28%. Therefore, before opting for the collection at the end of the loan, you should consider whether the accumulation in a single year could mean paying more personal income tax.
Example 2.An individual partner owns 100% of a company to which he makes a loan to his company of 150,000 euros over three years, at a rate of 5%. See the differences if the settlement of interest is annual or at maturity:
| Year | Anual | At Maturity | ||
| Interest | IRPF | Interest | IRPF | |
| Year 1 | 7.500 | 1.455 | – | – |
| Year 2 | 7.500 | 1.455 | – | – |
| Year 3 | 7.500 | 1.455 | 23.643 (1) | 4.845 |
| Total IC | 4.365 | 4.845 | ||
By requiring them at maturity, the total interest is higher (this is because the interest accrued each year is added to the total debt).
In this particular case, since it is a loan from a partner to his or her company for a large sum, deferring the interest to maturity is not as beneficial. However, for smaller sums, this option may be appropriate. Check in each case what is in your best interest.
